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FRM Part II · FRM Exam Part II · Stress Testing Banks

A bank's risk committee is reviewing its stress testing program. Senior management argues that because the bank's VaR model has performed well in backtesting, the stress testing program can be scaled back. Which response best reflects the purpose of stress testing relative to VaR?

Stress testing complements VaR by examining extreme but plausible events that historical, statistical models may miss. Good VaR backtesting does not remove this need, because VaR is limited by its confidence level and data window, so stress tests remain essential.

  1. AStress testing is redundant when VaR backtesting results are satisfactory
  2. BStress testing complements VaR by examining losses from extreme but plausible events that statistical models based on historical data may not captureCorrect
  3. CStress testing replaces VaR for regulatory capital purposes at all banks
  4. DStress testing is only needed when VaR exceptions exceed the regulatory threshold

Explanation

Stress testing addresses tail events and structural breaks that VaR, calibrated on historical data and a confidence level, may understate. It is a complement, not a substitute, and is needed regardless of backtesting performance. The other options misstate its role.

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